Are You Modular or Integral? Be Sure Your Supply Chain Knows

The hidden source of business model malaise: mismatched architectures.

Two of the most successful automobile companies of the 1990s were Daimler-Benz and Chrysler. Each entered the decade on somewhat shaky ground, each prospered enormously during the decade, and each mastered a very different business model. Unfortunately, when Daimler-Benz acquired Chrysler for $36 billion in 1998, their two business models proved incompatible. The new company, DaimlerChrysler AG, has suffered since then; its share price has dropped nearly in half, and annual profits, more than $7 billion just after the merger, are now around $562 million. There is a critical lesson to learn from the story of this merger: Had Daimler-Benz designed a strategy based on the differences between the two business models, it might be better equipped now to weather the current storms.

Chrysler’s business model in the 1990s — as detailed in the book Collaborative Advantage: Winning Through Extended Enterprise Supplier Networks, by Jeffrey H. Dyer (Oxford University Press, 2000) — emphasized four elements: rapid, innovative vehicle design; a high degree of outsourcing with a large number of suppliers; high levels of trust among these suppliers, enabling mutual support for interoperability; and extreme focus on cost reduction through supplier innovation. To a significant degree, these elements worked together as a single system, constituting a “modular” approach, with independently developed subsystems manufactured by relatively autonomous suppliers to work well together.

In the Chrysler business model, braking, exhaust, and climate control systems, for example, were each managed autonomously by a supplier who might be responsible for developing such systems for multiple Chrysler models. Because they outsourced the development and manufacturing of these modules and gave their suppliers leeway to innovate in ways they saw fit, Chrysler’s design teams gained the time they needed to focus on fashioning new vehicles and on updating older ones. Cost reduction among suppliers was encouraged with information sharing, long-term commitments, and contracts that gave these companies a significant portion of the savings. Buoyed by these partnership relationships, enthusiastic suppliers took on additional design and development work for components and subsystems, offering ever more creative cost-reduction efforts and even lower prices, leading to significant savings for Chrysler’s manufacturing and engineering operations.

Chrysler management set aggressive cost targets throughout the organization, and the net result was a more efficient, tightly structured, earnings-driven company, especially compared with the Chrysler of the 1980s. Best of all, this strategy allowed the automaker to introduce many timely and innovative new products, particularly highly profitable pickup trucks and sport utility vehicles as well as head-turning “image” vehicles such as the Prowler and Viper. Sales and profits soared.

Mercedes, the primary automobile brand of Daimler-Benz, had entered the 1990s with a very different business model — one based on designing, engineering, and manufacturing its cars in a seamless, “integral” way. Suppliers’ engineers were required to work cheek to cheek with Daimler-Benz’s engineers to ensure the flawless integration of all vehicle subsystems. Achieving superior rides, performance, and durability required no less. Because of this focus on perfection and handcrafted care, Daimler-Benz had never moved fully from craft to mass production. The company made lovingly built, handcrafted Mercedes cars that were very expensive to produce and own. Labor content per vehicle was high compared with lean and even mass-production plants, and product cycle times were measured in decades. By the early 1990s, when each of the Japanese Big Three had debuted a premium nameplate (Toyota’s Lexus, Honda’s Acura, and Nissan’s Infiniti), many buyers concluded they could get luxury at a lower cost. Mercedes had to change.

The automaker’s response to the threat of Japanese luxury vehicles was to finally take lean production seriously. Daimler-Benz embraced the principles of just-in-time manufacturing and kaizen (continuous improvement) in its operations, emphasizing faster product development, shorter supply chain lead times, and continuous inventory reduction. In doing this, the Mercedes unit brought factory efficiencies much more in line with worldwide standards, but still retained close relationships among the engineering groups who designed and built each vehicle and its outsourced subsystems. The resulting process improvements enabled the company to leverage its brand-name new vehicles more quickly. These innovations enhanced the company’s existing capability for producing flawless luxury automobiles. Like Chrysler, Mercedes saw its sales and profits soar.

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